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Sans Subpoena

A widely diverse group of nations
(The site of so many vacations)
Is finding of late
Their slowing growth rate
Has caused currency fluctuations

The EMG market arena
From Turkey down to Argentina
Has seen steep declines
Amid bad headlines
Now buyers won’t come sans subpoena

While the focus of this note has generally been on the major currencies, recent price action, where the dollar continues to power ahead overall, has started to really have an impact on emerging market currencies. In fact, the real question in this space is just how far can they fall? I have written before about the weakest links in the EMG space, those countries running significant current account deficits, and those are the countries that are leading the way lower on the currency front. Argentina, Russia, Brazil, India, Turkey and the Philippines are top (bottom?) of the list. In fact, they have fallen so much collectively over the past month, that it has become the most popular discussion topic of the morning. Well that, and how will the Fed react to Unemployment below 4.0%. But let’s look at the EMG laggards for now. Here’s how much these currencies have fallen this year:

ARS 17.4%
RUB 11.9%
BRL 6.5%
INR 5.2%
TRY 11.9%
PHP 4.1%

It is important to remember that at the beginning of the year, when the narrative had the dollar set to fall sharply and Goldilocks still alive and well, these were among the favored trades for investors. Each of these have higher interest rates than in the US, and there were many who felt it was a no-brainer to establish the carry trade, borrowing dollars to short against owning this diverse group of currencies. Well, that trade has come a cropper, now showing negative returns for the year and with the dollar’s latest move higher, looking like it can only get worse. In fact, given the continued positive economic news from the US, as well as the prospects for ongoing rises in US interest rates, my sense is that these currencies have further to fall. With yields in the US back to approaching some sense of value, or at least having finally turned positive on a real basis, the appetite for this bloc, in general, is likely to remain more limited. Hedgers beware of further declines here. While it may be expensive to hedge assets in these nations, it feels like it will be a lot more expensive not to!

Now back to the G10 world. As I’m sure everyone is already aware, Friday’s Unemployment Rate print of 3.9% was the lowest since December 2000. While the headline NFP number was a little light, the revisions to the past months made up the slack. In fact, the only data point that was somewhat disappointing was AHE, which at 2.6% was a bit softer than expected. In the end, though, there is no question that the labor market in the US remains quite strong. In fact, as the Unemployment rate continues to decline, the doves’ argument that there is still substantial slack in the labor market is becoming harder to make. The point is that the evidence continues to grow that the Fed is going to raise rates at least four times in total this year, and depending on how the data evolves, one cannot rule out a fifth hike toward the end of the year.

Meanwhile, the evidence of slowing growth elsewhere in the world continues to mount with the latest data point Germany’s Factory Orders, which declined -0.9%, well below expectations and the third consecutive monthly decline. And it’s not just Germany, but the Eurozone as a whole, which showed Retail PMI falling below 50 last month (48.6), a seventeen-month low. In other words, the idea that the US continues to grow solidly while the rest of the world slips back remains the prevalent theme. And there is no reason to think that the dollar will suffer any time in the near future accordingly.

Looking ahead, this week brings some important new information as follows:

Today

Consumer Credit

$16.0B

Tuesday

NFIB Small Biz Optimism

105.0

JOLTS Jobs

6.1M

Wednesday

PPI

0.3%

-ex food & energy

0.2%

Thursday

BOE Rate Decision

0.5% (unchanged)

Initial Claims

220K

CPI

0.3% (2.5% Y/Y)

-ex food & energy

0.2% (2.2% Y/Y)

Friday

Consumer Sentiment

99.0

At this stage, the idea that the BOE will raise rates has completely been priced out of the market. Rather, there will be a great deal of interest to see how they update their economic and inflation forecasts, which arguably should be lower than before. And here in the US, all eyes will be on Thursday’s CPI print, where anything above expectations will simply add to the idea that the Fed will be even more aggressive than currently priced. In the end, there is nothing that would have me change my view that the dollar will continue to be the top performer going forward. Look for continued gradual dollar appreciation as the week progresses.

Good luck
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3 thoughts on “Sans Subpoena”

The Fed’s assumptions about what is “full employment”, and the effect of that on wage growth may need reexamination. I live in Japan, and our unemployment rate is down to about 2.5% (SA) now. Yet wages hardly budge. In the part-time arena, job openings to applicants is nearly 3 to 1. We are almost literally crying for workers here. But there, too, wages hardly budge. I wonder if the same scenario can come to pass in the US.

I hear what you are saying, but inflation is coming here despite the lack of wage pressures and that’s really the issue I think. Can the Fed let inflation rise to 2.5% even if wages rise at only 2.8% and do nothing? I don’t think that’s an option for them. So while you may be correct and NAIRU is lower than currently assumed, inflation is trending sharply higher and is not about to stop soon. Rates here are going to go up, at least for a while longer.